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Delaware Small Cap Core Fund Quarterly commentary December 31, 2014

Within the Fund

Delaware Small Cap Core Fund (Class A shares at net asset value and Institutional Class shares) posted strong returns but failed to keep pace with its benchmark, the Russell 2000 Index, during the fourth quarter of 2014. Stock selection in the energy, technology, and consumer discretionary sectors detracted the most from the Fund’s relative performance. Contributions to relative returns were driven by stock selection in the capital goods, basic materials, and consumer services sectors. The Fund ended the quarter with the largest overweights to the finance, communications services, and consumer services sectors and the largest underweights to the consumer discretionary, utilities, and credit cyclicals sectors.

A number of stocks contributed to the Fund’s excess return during the quarter. The strongest contributor was WageWorks, a provider of consumer-directed benefit programs to employees including flexible spending accounts. The stock appreciated 42% during the quarter, a result of better-than-expected earnings and revenue growth. We believe the company may be positioned well to benefit from the expanding market opportunity and secular shift towards consumer-directed healthcare plans. NPS Pharmaceuticals, a biopharmaceutical company, rose 38% during the quarter as there is growing conviction that the Food and Drug Administration (FDA) will approve its new drug, Natpara, which is intended to treat a niche orphan disease, hypoparathyroidism. Popeyes Louisiana Kitchen appreciated 39% during the quarter as the company continues to outperform its peers in same-store sales, both domestically and internationally. The company indicated at its investor day a plan for international growth and shareholder friendly actions such as additional share repurchases.

During the second half of 2014, the precipitous drop in energy prices resulted in dramatic underperformance across the sector. The decline in the price of oil can be attributed first to the strengthening dollar and then to the unwillingness of the Organization of the Petroleum Exporting Countries (OPEC) to reduce production following its November meeting. In general, the biggest declines were exhibited in the oil and gas equipment and services industry, followed by oil and gas exploration and production companies. We saw the companies with higher leverage experience more dramatic declines than those exhibiting stronger financial characteristics.

The stocks in held in the Fund were not immune to the decline in energy prices. Jones Energy is a Texas-based exploration and production company with resources in Texas and Oklahoma — the stock was down 45% during the quarter. We sold the Fund’s position in Jones Energy during the quarter. However, we continue to own Rosetta Resources (which declined 50% during the quarter), an exploration and production company — in our view, the company has good acreage and is making efforts to improve its capital spending budget. Exploration and production companies are engaging in conversations with their service providers to make the best of this depressed price environment. We believe this should result in pricing pressure for service providers like C&J Energy Services (which declined 53%) — therefore, we exited the Fund’s position during the quarter.

Outlook

Both the earnings and sales growth outlook remain strong for small-cap stocks. We continue to believe small-caps are the most favorable way to leverage the strength of the U.S. economy, since small-cap companies derive a higher percentage of their sales in the United States than mid- or large-cap companies.

The market pullback that occurred in the third quarter was reversed by strong performance in the fourth quarter, allowing small-cap stocks to end the year in positive territory. After a year of good earnings, we enter 2015 with lower valuations than where they were when the year began. We will keep a close eye on top-line growth and leading economic indicators for signs of weakening in the economy. The U.S. Federal Reserve is expected to raise rates in 2015 and will most likely do so if it thinks the economy is strong enough to stand on its own. If it comes as a result of an economic expansion, we would view a move in the fed funds rate as a net-positive development, particularly given small-cap stocks’ close ties to the domestic economy.

The increase in mergers-and-acquisitions activity this year has met our expectations and we anticipate that this trend should continue given the healthy levels of cash on corporate balance sheets, as well as favorable credit market conditions. Capacity utilization is back at its long-term average, which should instill business confidence and potentially lead to increased capital expenditures.

Our research continues to favor companies with what we view as strong balance sheets and cash flow, sustainable competitive advantages, and high-quality management teams, which we believe have the potential to outperform over the cycle.

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The views expressed represent the Manager's assessment of the Fund and market environment as of the date indicated, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Information is as of the date indicated and subject to change.

Document must be used in its entirety.

Performance

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted.

Performance data current to the most recent month end may be obtained by calling 800 523-1918 or visiting delawareinvestments.com/performance.

Total returns may reflect waivers and/or expense reimbursements by the manager and/or distributor for some or all of the periods shown. Performance would have been lower without such waivers and reimbursements.

Average annual total return as of quarter-end (12/31/2014)
Current
quarter
YTD1 year3 year5 year10 yearLifetimeInception
date
Class A (NAV)9.54%8.58%8.58%21.38%18.18%8.31%11.18%12/29/1998
Class A (at offer)3.26%2.36%2.36%19.01%16.80%7.66%10.77%
Institutional Class shares9.63%8.84%8.84%21.70%18.47%8.56%11.35%12/29/1998
Russell 2000 Index9.73%4.89%4.89%19.21%15.55%7.77%n/a

Returns for less than one year are not annualized.

Class A shares have a maximum up-front sales charge of 5.75% and are subject to an annual distribution fee.

Prior to Aug. 1, 2005, the Fund had not engaged in a broad distribution effort of its shares and had been subject to limited redemption requests. 12b-1 fees were waived for this period. Had 12b-1 fees been applied, performance would have been lower. Expense waivers were in effect for the periods shown. Performance would have been lower if waivers did not apply.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

Russell 2000® Index (view)

Expense ratio
Class A (Gross)1.31%
Class A (Net)1.31%
Institutional Class shares (Gross)1.06%
Institutional Class shares (Net)1.06%
Top 10 holdings as of 12/31/2014
Holdings are as of the date indicated and subject to change.
List excludes cash and cash equivalents.
Holding% of portfolio
Casey's General Stores Inc.1.3%
West Pharmaceutical Services Inc.1.3%
Cepheid1.2%
XPO Logistics Inc.1.2%
NPS Pharmaceuticals Inc.1.1%
DexCom Inc.1.1%
j2 Global Inc.1.1%
G-III Apparel Group Ltd.1.1%
LaSalle Hotel Properties1.1%
Proofpoint Inc.1.1%
Total % Portfolio in Top 10 holdings11.6%

Institutional Class shares are only available to certain investors. See the prospectus for more information. 

All third-party marks cited are the property of their respective owners.

Carefully consider the Fund’s investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Fund’s prospectus and its summary prospectus, which may be obtained by clicking the prospectus link located in the right-hand sidebar or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

Investing involves risk, including the possible loss of principal.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors.

Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies.

REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.

International investments entail risks not ordinarily associated with U.S. investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations.

Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

Not FDIC Insured | No Bank Guarantee | May Lose Value